Dow futures signal another bumpy ride on Wall Street

Glen Norman
February 9, 2018

Wall Street ran out of steam on Wednesday after an early surge as investors were still cautious after a bruising selloff that saw the Dow Jones Industrial Average post its biggest intraday fall on record on Monday.

Stocks have swung wildly over the past week.

And it's now in a correction - 10% off its record high just two weeks ago.

Here's what's driving the volatility. The strength of the global economy and corporate earnings are still providing support for stocks. The job market remains healthy, as evidenced by a report Thursday that applications for unemployment benefits are at a 45-year low.

Companies are starting to pay workers more to retain existing employees and attract new hires. Momentum seems skewed toward further price declines, they say, even as relative-strength index analysis suggests Treasuries are on the verge of being oversold.

Though the economy has been growing steadily for nearly nine years, price inflation has remained stubbornly and mysteriously low. USA data showed an unexpected build in refined products, fanning fears of oversupply headed into the slow-demand season. The BoE raised its growth forecasts for Britain due to the strong global recovery. Bets have already re-emerged on four Fed hikes this year, rather than the three signaled by officials. But if inflation picks up, the Fed could raise rates more often or more steeply than it had planned.

"We have seen the US Fed warning the markets that it would be raising interest rates". Interest rates affect everything from mortgages to auto loans, but are particularly important for calculating the value of anything expected to generate profits in the future.

The suspension of shares in Produce Exchange Trust Company prompted fears of a market bubble in industrial stocks. "There is no doubt interest rates will rise and liquidity will be withdrawn but it will be gradual and calibrated in nature", said Shah of Kotak Mutual Fund. The thing that was worrying investors was the speed at which things were changing.

Stocks have also been on a tear because they have been one of the only investments with a decent return.

But fresh Dow buying did little for European stock markets which closed the day more than a percent lower, although Frankfurt fared somewhat better. To take that risk, one would certainly seek a risk premium over risk-free or less risky assets such as bonds.

The U.S. dollar rose against a basket of currencies as the U.S. bond market selloff levelled off.

"The news yesterday has set up a test for 3 per cent on 10-year Treasury yields", Savary said. A supply glut could devalue bonds.

For now, the market is moving toward higher yields, and strategists are hesitant to call an end to the rout.

Inflation is bad for bonds, too. "Once yields rise to a certain level, stock investors begin to get attracted to low-risk bond yields instead of higher-volatility stock investments, and contributing to that are equity valuations above historic averages". The bond yield/equity yield or BEER ratio at 1.85 makes equities look overvalued.

Trading has been extremely choppy, and the market has swung in wide ranges - up and down almost 2,300 points over the past week.

While perhaps not the overriding factor, the oil price will be worth monitoring to see if any significant and sustained correction precipitates a halt to the current bond market sell-off. There could be a little groupthink taking place in the downturn.

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